Mutual funds: Why investors stick with bad funds

Published October 07. 2012 4:00AM

Chuck Jaffe

Publication: The Day

Some people were surprised this week when Janus Capital Management announced that it was killing off Janus Worldwide - once one of the biggest, most respected funds in the industry - by merging it into a smaller sister fund.

The more appropriate response was "What took them so long?"

Fund companies euthanize their weakest offspring all the time, but they work hard to keep their cash cows - the recognized names that deliver large fees long after performance no longer deserves the big bucks.

The question is why investors stick around to the bitter end, because while Janus Worldwide has seen its assets shrink to roughly $1.9 billion - down from about $45 billion before the Internet bubble burst in 2000 - its performance was bad enough that you'd be hard-pressed to justify keeping $1.90 (that's one-billionth of the fund) in there.

Where Janus Worldwide (JAWWX) once was a model of mutual fund investing success, it goes out as a cautionary tale of why investors need to get past the flawed thinking that gets them to fall in love with a fund and stick with it when its results turn abusive.

To see why, let's first recap the Worldwide story.

From its May 1991 inception until the tech bubble burst in March of 2000, Janus Worldwide returned nearly three times the cumulative return of the typical world-stock fund, according to Morningstar Inc. Janus was the hottest fund company in the business - Worldwide narrowly lagged the flagship Janus fund (JANSX) in assets - with seemingly every investor loading up on every growth-oriented flavor the firm offered.

But when the growth stopped, all of those funds went south together; unlike other Janus funds, Worldwide never really recovered.

After being crushed in the ensuing bear market, star manager Helen Young Hayes retired in 2003. A year later, her remaining co-manager, Laurence Chang, was replaced by Jason Yee, whose aggressive bets in financial stocks and energy companies ended a five-year stretch where the fund was in the bottom 15 percent of its peer group, but who still lagged more than half of his peer group during his "best times."

Yee left in 2009 - ironically the first year since the boom times when the fund finished in the top-third of its category - and then things got weird. His replacement jumped ship after 13 months, and the job was held by an interim manager until current manager, George Maris, was installed early in 2011.

Fund investors typically find reasons for hope in manager changes, but the turnover didn't help Worldwide. Those managers combined to average a 4.4% annualized gain over the last decade, about two full points below the category average and in the bottom 2 percent of Morningstar's world stock group. Even with its late 1990s salad days lumped into results, the fund's 15-year record ranks in the bottom 5 percent of its peers.

The merger with Janus Global Research (JARFX) is a mercy killing. Technically, Global Research will be merged into Worldwide - purportedly to limit proxy solicitation costs paid by shareholders - but it will be the bigger fund with the lesser track record that ultimately disappears.

Worldwide shareholders are getting an upgrade that, without the deal, most probably wouldn't have executed themselves.

Shareholders stick with lousy funds for several reasons, most based on flawed thinking. If these apply to your logic in sticking with a laggard, you probably should come to your senses rather than waiting for your fund sponsor to change things for you.

• "It was good to me once."

The most dangerous of excuses, this is how you take a fund that has a few good years, like Worldwide during the Internet boom, and tolerate underperformance for over a decade.

If a fund's glory days are long gone and you would not buy it again today if you were starting over, stop hanging on.

• "I'm waiting to get back to break-even."

Break-even is neither a goal nor a guarantee. You may recover losses faster by selling out and buying a new fund than by waiting for a laggard to stumble back to the starting line.

Worse yet, many investors recover their losses, as Worldwide shareholders did, but don't sell when they cross that purported finish line. Instead, they use break-even as a reason to expect performance to improve; this is how a fund stays in the portfolio despite not meeting expectations for decades.

• "It's really not so bad."

Settling for disappointment has consequences; a percentage point or two over long stretches of time makes a real difference over a lifetime of investing.

• "It has new management."

A new manager may be reason to stick around … for 12 to 18 months. Constant managerial change - and failure - is not something that should engender your trust.

• "I don't want to pay the taxes."

No one likes paying taxes on their gains - small or large - but the easiest way to avoid gains is to lose money. The second-easiest way is to hold an investment that barely makes any.

Sticking with a bad fund will take more out of your returns in the long run than Uncle Sam's cut.